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The Economy: What's Wrong and How to Fix It

OK, that’s biting off a lot, I know. But really, isn’t that the question you’d like answered?

I’m here to help. I’m from the wonk world, and the folks at Rolling Stone have asked me to contribute a weekly online column starting next year. I’m jumping the gun here because … well, because there’s just so much wrong with the way we’re going at economic policy in America right now, and some of the political battles taking place in real time offer a great example.

I know it’s tempting to put off important matters, like restructuring the $15 trillion American economy to much more effectively meet the needs of the people in it, until after the holidays. But there’s simply no time to waste in getting this right.

Simply put, the answer to the question posed in the title to this column is this: The way most policy makers and too many economists understand the economy is wrong. It’s driven by wrong beliefs – for example that:

• markets can monitor and correct themselves without government oversight

• trickle-down economics (the idea that you cut taxes for the wealthy and that creates more work for everyone else) actually works

• government can’t help (and more often than not does harm) in either of the above cases – either in regulating markets or stimulating job creation.

And what's the support for these beliefs? There is none. In fact, the evidence points the other way. The Great Recession itself was the result of a housing bubble born, in part, of a negligent lack of oversight into the activities of the banking and housing finance sectors. The G.W. Bush years provided an excellent test of trickle-down: both job growth and middle-class incomes did worse in those years than any other business cycle expansion on record. And government policy failed to effectively regulate incendiary markets and to ensure that more of the economy’s growth and jobs reached the middle class.

A new economic model must rise from the ashes of the Great Recession, one built upon the non-reality of the above three myths. Markets, particularly financial markets, need regulating; if we cut more taxes for the wealthy, we simply make them wealthier and worsen our fiscal outlook by piling up ever-larger debts and deficits; and we need a government capable of dealing with these market failures.

On that last point, this past week has truly been one for the record books in terms of the dysfunctionality of the current Congress.

The fight that ended yesterday afternoon was over the extension of the payroll tax cut, which adds two percent to your paycheck, and unemployment insurance. The former provides support for strapped families, and the latter is an obviously important part of the safety net in a job market with four unemployed people per job opening. Both were scheduled to expire at the end of this month.

These should have been absolute slam dunks. Why? First, millions of middle-class and low-income Americans are struggling – many are unemployed or, if they’re working, their paychecks don’t go as far as they used to, and many are saddled with too much debt; they need help. Second, the larger economy needs help too. Americans with less money in their pockets are spending less, which hurts the businesses that need to sell them goods and services. Companies enjoying big profits from overseas sales are sitting on the sidelines instead of investing in new projects here at home. Bottom line: The economy needs more demand, and neither consumers nor businesses are providing it.

That leaves the federal government as the only actor in the economy that can pump up a bit of demand right now. (And, for the record, note that when we talk about the payroll tax cut and unemployment insurance, we’re talking about continuing stuff that’s already been keeping the economy from backsliding – we’re not talking about adding anything new. We should be, but let’s save that for another column.) For now, extending the tax cut and unemployment insurance (for at least a year, by the way, not just two months) is the best thing we can do to help the economy and relieve the crunch on millions of American households.

What makes me so confident this is the way to go? Two things: simple arithmetic and, more important, hard evidence.

On the math side, the economy is simply the sum of consumer spending, investment, government spending and net exports. That’s all there is to it. And when consumers are tentative, investors respond in kind. Only the federal government has the reliable capacity to temporarily give the economy a boost while the private sector is largely out of commission.

What’s more, the evidence supports the math. Despite all the misinformation, the economic stimulus package known as the Recovery Act was highly effective in keeping things from getting a lot worse. (True, you don’t win a lot of arguments based on “it coulda been worse!”… but there it is.)

Look, this isn’t rocket science. (Rule of thumb: When economics tries to emulate rocket science as opposed to common sense, it generally departs the realm of the real world.) In tough times, if you give people, especially middle-class and low-income people, a break in their paychecks and provide the unemployed with a bit more income, they’ll spend it. And that helps sustain growth until the economic engine is once again firing on its own power.

The problem is that while President Obama’s efforts at stimulus, starting in 2009, built a bridge across the chasm of the Great Recession, that bridge wasn’t long enough. The president recognized as much, which is why he put forward a $450 billion add-on, the American Jobs Act. Nothing’s perfect, but pieces of this legislation – keeping teachers and cops on the job, fixing up the public schools, the tax and unemployment benefits noted above – are just the extra planks we need in that bridge.

Yet, we're nowhere close to legislating these measures. This week the House Republicans found a way to get under the already impossibly low bar we’ve set for them. It looks like UI and the payroll tax cut — and the people who depend on them — dodged a bullet, if only for two months, as the tea partiers caved. But while I’m very glad that’s over, what just transpired is a microcosm of a much larger and downright scary problem.

We have reached a point where we can no longer self-correct when the economy goes haywire. Because so many of our lawmakers – mostly Republicans I’m afraid – and too many of our economists are so blinded by ideology (that is, they buy actually buy into the myths I mentioned above) and so unwilling to compromise politically, that we've lost the ability to accurately diagnose our economic ailments, let alone prescribe an urgent remedy as simple as providing people with a wage boost and a safety net in a recession.

This needs to change, and quickly. Constructing a new and more effective model for economic policy will be a key theme of this column in the new year. I’ll try to come at the broader economic issues each week by zoning in on some tangible example of how we’re getting it wrong or right.

Jared Bernstein is a senior fellow at the Center on Budget and Policy Priorities. From 2009 to 2011, he was the Chief Economist and Economic Adviser to Vice President Joe Biden, executive director of the White House Task Force on the Middle Class, and a member of President Obama’s economic team.